When it comes to personal finance and the accumulation of wealth, few subjects are more talked about than stocks. It’s easy to understand why: investing in the stock market is thrilling. But on this financial roller-coaster ride, we all want to experience positive returns.
In this article , we examine a strategy used to identify good stocks (or at least avoiding bad ones). In other words, we’ll explore the art of stock-picking - selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market’s overall average.
Before exploring the vast world of stock-picking methodologies, we should address a misconception. Many investors who are new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. However, there is no foolproof system for
CAN SLIM is a philosophy of screening, purchasing and selling stocks. It was developed by William O’Neil, the co-founder of Investor’s Business Daily. The name may sound boring, but this acronym actually stands for a very successful
What makes CAN SLIM different is its attention to tangibles such as earnings, as well as intangibles as a company’s overall strength and ideas. The best thing about this strategy is that there’s evidence that it works: there are countless examples of companies that, over the last half of the 20thcentury, met CAN SLIM criteria before increasing enormously in price. In this section we explore each of the seven components of the CAN SLIM system.
C = Current Earnings
O’Neil emphasizes the importance of choosing stocks whose earnings per share (EPS) in the most recent quarter have grown on a
Earnings Must Be Examined Carefully
The system strongly asserts that investors should know how to recognize low-quality earnings figures. That is, figures that are not accurate representations of company performance. Because companies may attempt to manipulate earnings, the CAN SLIM system maintains that investors must dig deep and look past the superficial numbers companies often put forth as earnings figures.
O’Neil says that, once you confirm that a company’s earnings are of fairly good quality, it’s a good idea to check others in the same industry. Solid earnings growth in the industry confirms the industry is thriving and the company is ready to break out.
A = Annual Earnings
CAN SLIM also acknowledge the importance of annual earnings growth. The system indicates that a company should have shown good annual growth (annual EPS) in each of the last
How Much Annual Earnings Growth?
It’s important that the CAN SLIM investor, like the value investor, adopts the mindset that investing is the act of buying a piece of a business, becoming an owner of it. This mindset is the logic behind choosing companies with annual earnings growth within the 25-50% range. As O’Neil puts it, “who wants to own part of an establishment showing no growth”?
N = New
O’Neil’s third criterion for a good company is that it has recently undergone a change, which is often necessary for a company to become successful. Whether it is a new management team, a new product, a new market, or a new high in stock price, O’Neil found that 95% of the companies he studied had experienced something new.
S = Supply and Demand
The ‘S’ in CAN SLIM stands for supply and demand, which refers to the laws that govern all market activities. The analysis of supply and demand in the CAN SLIM method maintains that, all other things being equal, it is easier for a smaller firm, with a smaller number of shares outstanding, to show outstanding gains. The reasoning behind this is that a large cap company requires much more demand than a smaller cap company to demonstrate the same gains.
O’Neil explores this further and explains how the lack of liquidity of large institutional investors restricts them to buying only large-cap, blue chip companies, leaving these large investors at a serious disadvantage that small individual investors can capitalize on. Because of supply and demand, the large transactions that institutional investors make can inadvertently affect share price, especially if the stock’s market capitalization is smaller. Because individual investors invest a relatively small amount, they can get in or out of a smaller company without pushing share price in an unfavorable direction.
L = Leader or Laggard
In this part of CAN SLIM analysis, distinguishing between market leaders and market laggards is of key importance. In each industry, there are always those that lead, providing great gains to shareholders, and those that lag behind, providing returns that are mediocre at best. The idea is to separate the contenders from the pretenders.
I = Institutional Sponsorship
CAN SLIM recognize the importance of companies having some institutional sponsorship. Basically, this criterion is based on the idea that if a company has no institutional sponsorship, all of the thousands of institutional money managers have passed over the company.
However, be wary if a very large portion of the company’s stock is owned by institutions. A company can be institutionally over-owned and, when this happens, it is too late to buy into the company. If a stock has too much institutional ownership, any kind of bad news could spark a spiraling sell-off.
O’Neil also explores all the factors that should be considered when determining whether a company’s institutional ownership is of high quality. Even though institutions are labeled “smart money”, some are a lot smarter than others.
M = Market Direction
The final CAN SLIM criterion is market direction. When picking stocks, it is important to recognize what kind of a market you are in, whether it is a bear or a bull. Although O’Neil is not a market timer, he argues that if investors don’t understand market direction, they may end up investing against the trend and thus compromise gains or even lose significantly.
Daily Prices and Volumes
The best way to keep track of market conditions is to watch the daily volumes and movements of the markets. This component of CAN SLIM may require the use of some technical analysis tools, which are designed to help investors/traders discern trends.
Here’s a recap of the seven CAN SLIM criteria:
C = Current quarterly earnings per share - Earnings must be up at least 18-20 percent.
A = Annual earnings per share – These figures should show meaningful growth for the last
N = New things - Buy companies with new products, new management, or significant new changes in industry conditions. Most importantly, buy stocks when they start to hit new price highs. Forget cheap stocks; they are that way for a reason.
S = Shares outstanding - This should be a small and reasonable number. CAN SLIM investors are not looking for older companies with a large capitalization.
L = Leaders - Buy market leaders, avoid laggards.
I = Institutional sponsorship - Buy stocks with at least a few institutional sponsors who have better-than-average recent performance records.
M = General market - The market will determine whether you win or lose, so learn how to discern the market›s overall current direction, and interpret the general market indexes (price and volume changes) and action of the individual
CAN SLIM is great because it provides solid guidelines, keeping subjectivity to a minimum. Best of all, it incorporates tactics from virtually all major investment strategies. Think of it as a combination of value, growth, fundamental, and even a little technical analysis.
Remember, this is only a brief introduction to the CAN SLIM strategy; this overview covers only a fraction of the valuable information in O’Neil’s book, “How to Make Money in Stocks”. It is recommended to engage in research to fully understand the underlying concepts of CAN SLIM.